DISCUSSION PAPER 2014-06 | OCTOBER 2014
The Path to Water Innovation
Newsha K. Ajami, Barton H. Thompson Jr., David G. Victor
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GEORGE A. AKERLOF
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SUZANNE NORA JOHNSON
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MELISSA S. KEARNEY
Director
The Path to Water Innovation
Newsha K. Ajami
Stanford Woods Institute for the Environment
Barton H. Thompson Jr.
Stanford Woods Institute for the Environment and Stanford Law School
David G. Victor
University of California, San Diego
OCTOBER 2014
NOTE: This discussion paper is a proposal from the authors. As emphasized in The Hamilton Project’s
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The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
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Abstract
For more than a century the United States’ water system has been one of the most reliable in the world. Today, it provides sufficient
water to support over 315 million people, almost 55 million acres of irrigated farmland, and a $16 trillion economy. Yet the water
sector faces increasing pressures. Growth in population and the economy, along with urbanization and land-use changes, are
threatening both water quality and the ability to meet water demand. Looking to the future, climate change is expected to further
stress water systems in large parts of the country. Water infrastructure, by some measures the oldest and most fragile part of the
country’s built environment, has decayed.
Solutions to the country’s growing water challenges lie, in part, with the development and adoption of new innovative technologies.
Yet, in comparison to the electric power sector, investment in water innovation is extremely low. Indeed, investment by the
savviest promoters of innovation—such as venture capital and corporate research and development—are strikingly low in the
United States and globally when compared with other major sectors of the economy. This low investment helps explain low levels
of innovative output, as measured by patent filings and other data. Adoption and dissemination of new innovations are also slow.
The primary barriers to innovation are related to the way that the many layers of governmental agencies and water entities
manage the nation’s water sector. Among the main management and policy barriers are (1) unrealistically low water pricing
rates; (2) unnecessary regulatory restrictions; (3) the absence of regulatory incentives; (4) lack of access to capital and funding;
(5) concerns about public health and possible risks associated with adopting new technologies with limited records; (6) the
geographical and functional fragmentation of the industry; and (7) the long life expectancy, size, and complexity of most water
systems. Although the last three factors are inherent to the water sector and hard to change, substantial policy reforms are
feasible that could alter pricing, regulation, and finance in the water sector—all in ways that would encourage innovation.
We focus on several recommendations: (1) pricing policies that would both better align with the full economic cost of supplying
water and decouple revenues from the volume of water supplied; (2) regulatory frameworks to create an open and flexible
governance environment that is innovation friendly and encourages valuable new technologies; and (3) financing and funding
mechanisms, such as a public benefit charge on water, that can help raise sufficient funds to implement innovative solutions. As
has been demonstrated in the clean energy sector, implementation of these policy reforms would facilitate greater innovation in
the water sector. In addition, we recommend the creation of a state-level water innovation vision that would identify state-specific
innovation opportunities and policies, along with state innovation offices to help implement the vision across the many varied
agencies and firms relevant to the sector. While we expect these state water innovation offices would become common, a small
group of states with the greatest water challenges—such as California, Florida, and Texas, or a consortium of like-challenged
states in a region such as the West—would begin the process. Based on the lessons learned, other states could follow.
2
The Path to Water Innovation
Table of Contents
ABSTRACT
2
CHAPTER 1. INTRODUCTION
5
CHAPTER 2. BACKGROUND
7
CHAPTER 3. STATE OF INNOVATION IN THE WATER SECTOR 11
CHAPTER 4. EXPLAINING PATTERNS OF INNOVATION
20
CHAPTER 5. INFUSING INNOVATION INTO THE WATER SECTOR
26
CHAPTER 6. CONCLUSION
33
CHAPTER 7. QUESTIONS AND CONCERNS
34
AUTHORS AND ACKNOWLEDGMENTS
36
ENDNOTES
38
REFERENCES
39
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
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4
The Path to Water Innovation
Chapter 1: Introduction
W
ater is indispensable to life and the nation’s social,
economic, and environmental well-being. For over
a century the United States has enjoyed reliable
and safe sources of drinking water and has virtually eradicated
most water-borne diseases. Through conservation, waterscarce regions of the country have met the needs of growing
populations and economies. Today, the nation’s water systems
provide sufficient water to support more than 315 million
people, almost 55 million acres of irrigated farmland, and a $16
trillion economy.
Although they have been highly
effective to date, the country’s
water supply systems are now
on the cusp of new challenges
that they are not prepared
to meet. Despite significant
gains in conservation in
recent decades, pressures on
water supply are mounting as
the population grows. Water
i n f rast r uc t u re—i nclud i ng
dams, reservoirs, aqueducts,
and urban distribution pipes—
is aging: almost 40 percent of
the pipes used in the nation’s
water distribution systems are
forty years old or older, and
some key infrastructure is a
century old. On average, about
16 percent of the nation’s piped water is lost due to leaks and
system inefficiencies, wasting about 7 billion gallons of clean
and treated water every day (U.S. Environmental Protection
Administration [EPA] 2013; Maxwell 2013).
(Bloomberg, Paulson, and Steyer 2014). Higher temperatures
will also raise evapotranspiration rates, further increasing
agricultural water needs.1 At the same time, increasing
environmental regulation is reducing the amount of water that
can be withdrawn from the nation’s rivers, lakes, and aquifers,
and groundwater overdraft is impacting water availability in
various basins (Zekster, Loaiciga, and Wolf 2005). The nation,
in short, will need to do more with less.
On average, about 16 percent of the nation’s
piped water is lost due to leaks and system
inefficiencies, wasting about 7 billion gallons
Climate change will further threaten water supplies while
increasing demand in some parts of the country. In areas such
as the West that are already prone to drought, climate change
is likely to shift storm tracks and thin snow packs (Pierce et
al. 2008). In those parts of the country, droughts are likely
to become worse and more prevalent (Cayan et al. 2010; Dai
2010). In coastal zones, the impacts of climate change will
be felt through stronger storms and coastal flooding that
could threaten the reliability of urban water supply systems
of clean and treated water every day.
New technologies can help the nation continue to grow in the
face of scarcer water supplies. New water technologies can
enable greater levels of economically affordable conservation
and increase productivity of available water sources through
increased efficiency, reducing overall demand for water.
Water supply technologies that recycle or desalinate water can
provide the nation with additional sources of water that are
better insulated from drought and other pressures affecting
traditional supplies. New water technologies also can help
water managers better characterize and manage groundwater
aquifers and complex river systems, permitting the nation to
maximize the yield of its existing water sources. Contaminants
of emerging concern and increasingly stringent drinking
water goals call for new purification technologies that can
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
5
help remove those contaminants and provide drinking water
of even higher quality (e.g., Savage and Diallo 2005).
While the water sector offers many opportunities to innovate
and deploy new technologies, in practice the sector has barely
tapped the potential those technologies offer. Various hurdles
currently inhibit the development, testing, adoption, and
diffusion of new water technologies. Research and development
(R&D) is a public good that is likely to be suboptimal in scale
without public financial support—a problem also faced in
other sectors of the economy such as the electric power sector
(Nemet and Kammen 2007). Indeed, firms and regulators in
the water sector could learn much by observing how other
analogous sectors of the economy have addressed the need for
new technology—yet very little of this cross-sectoral learning
actually occurs in the water sector. Various barriers have
inhibited fundamental change in recent decades in the basic
technologies. Addressing the coming challenges will require
new approaches.
6
The Path to Water Innovation
We put forth a new strategy to increase innovation and
deployment of new technologies in the water sector. Our
proposal is threefold: First, we call for a change in the pricing
of water to better match the economic cost of supplying water
and to foster more private-sector innovation. Improper water
pricing undercuts both the incentive for water-conserving
technologies by water users and the financial stability
needed to finance the adoption and implementation of new
water technologies by the water suppliers. Second, we call
for regulatory reforms at the subnational level to create
a more innovation-friendly environment. As part of this
recommendation we suggest that some states could benefit from
the creation of new water innovation offices to coordinate and
support pro-innovation policies. We argue that many current
regulations frequently hinder the adoption of cost-effective
technologies. Third, we call for a public benefit charge on
water to allow for more public funding for water innovation.
Taken together, these three major policy initiatives could
dramatically improve technological innovation in water and
lead to more-efficient outcomes in our nation’s water sector.
Chapter 2: Background
THE WATER SECTOR
The water sector can be divided into a number of subsectors,
including water supply, conveyance, treatment, and
distribution; the consumptive or end use of water by
agricultural, residential, commercial, and industrial users; the
collection, treatment, and disposal of wastewater; and water
recycling and distribution, which can also be considered a
part of the water supply subsector. Water is extracted from
a surface or groundwater source and conveyed to a water
treatment facility to be treated and purified to meet end-use
water quality standards before it is distributed to customers
in various sectors such as residential or agricultural (figure
1). Subsequently, wastewater is collected from various sectors
and transferred to a wastewater treatment plant for treatment
to meet environmental water quality standards before it
is returned to the environment (e.g., waterway, ocean, or
aquifer). In some cases, a portion of the wastewater could
be recycled—treated to a higher standard—and reused by a
prospective end-user.
In many regions of the country, management of water supply
and wastewater is fragmented by function. Water supply
entities generally supply, convey, purify, and distribute water
to a particular sector of the population or the economy.
Wastewater entities generally collect, treat, and dispose of the
wastewater.
The water sector is also geographically fragmented. According
to the U.S. Environmental Protection Agency (EPA),
approximately 155,000 drinking-water systems and 15,000
wastewater systems exist in the United States (EPA 2009).
Many of these systems are small, particularly in rural regions.
Diverse and highly localized technical, regulatory, and
FIGURE 1.
Water Distribution and Use Cycle
Water Source
(Surface or Groundwater)
Supply and Conveyance to a Region of Use
(e.g., City or County)
Water Treatment
to Meet End Use Water Quality Standards
Water Distribution to Consumers
Recycled Water Distribution
End Use: Agriculture, Residential,
Commercial, Industrial
Wastewater Collection
Recycled Water Treatment
Wastewater Treatment
Source: Modified from The Climate Registry and Water Energy Innovations 2013.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
7
institutional frameworks and policies have further added to
fragmentation and complexity in the water industry.
Another key feature of the water sector is the dominance
of publicly owned suppliers. This was not always the case.
Privately owned companies distributed most of the water
in the late eighteenth century and much of the nineteenth
century. However, concerns over high water rates, inequitable
distribution of water within urban communities, health risks
from untreated water, and low levels of reinvestment in water
systems led many cities to take over private water supply
systems in the late nineteenth century. While private water
suppliers still outnumber public suppliers in the United States,
public suppliers today furnish water to about 80 percent of the
nation’s domestic and commercial users and almost 20 percent
of its industrial users (Thompson, Leshy, and Abrams 2013).
Public water agencies also supply the water needed to irrigate
approximately a quarter of the irrigated acreage in the Western
United States (and over half of the irrigated acreage in California
The pattern of technological change
in the water sector has generally been
marked by stagnation.
and Washington), with most of the rest of the irrigation water
obtained directly from waterways or aquifers by the farmer or
rancher; private entities play only a small role in the supply and
distribution of irrigation water (Thompson 1993).
Public water entities are seldom subject to regulation by state
public utility commissions. As a result, local political processes
provide the principal oversight of public water suppliers. Most
public water suppliers are governed either by local government
officials (e.g., members of city councils) or by elected boards
(e.g., the board members of irrigation districts). In voting for
such officials, members of the local public generally seek three
goals: reliability, safety, and low water prices. Elections for
water officials are seldom contested except where these goals
are threatened.
8
The Path to Water Innovation
As explained in more detail below, a number of these factors—
high fragmentation, public ownership, political pressure for
low water rates, and reliability concerns—as well as other
issues, inhibit innovation. The past two centuries saw a
handful of fundamental technological changes in the water
sector, generally driven by health or environmental concerns.
In the early nineteenth century, advances in water treatment
enabled the delivery of safe, clean drinking water to the
nation’s growing cities, and helped protect populations from
contaminants causing contagious diseases, thereby reducing
disease rates in urban regions of the country (EPA 2000). The
invention of sewage treatment plants in the early twentieth
century led to greater protection of rivers, lakes, estuaries, and
other aquatic ecosystems (Sedlak 2014). In the final decades of
the twentieth century, passage of the Clean Water Act of 1972
(and its 1977 amendments) and the Safe Drinking Water Act of
1974 required further improvements in wastewater treatment
and improved ambient water quality, along with marginal
changes in the technology used for drinking-water treatment.
Since then, however, the pattern
of technological change in the
sector has generally been marked
by stagnation, although some
innovative water entities such as
the Orange County (CA) Water
District have continued to pursue
cutting-edge opportunities.
COMPARISONS TO THE
ENERGY SECTOR
Throughout this paper we draw
comparisons with the energy
sector—notably electricity—for
several reasons. First, because
the two sectors have many
similarities in technological
structure, such as the central role
of long-lived infrastructures,
comparisons of technological innovation can provide a
relevant sense of the relative level of innovation in the water
sector. Other economic sectors, such as biotechnology or
information technology, have significantly different industrial
structures and infrastructure turnover that is much more
rapid, leading to different potentials for innovation. As
described in more detail below in the section “Explaining
Patterns of Innovation,” comparisons between the water and
energy sector are complicated, so any conclusions are highly
conditional. Unfortunately, no simple and reliable measures of
innovation in the two industries exist, and potential measures
of innovation often cannot be directly compared from one
industry to the other. By looking at multiple indicators,
however, it is possible to triangulate on some general
conclusions regarding the scale of innovation and the factors
that can alter patterns of innovation.
risk-averse, since any system failure could have immense
social and economic impacts.
Second, policymakers and researchers have focused much
more on the policies that could increase innovation in the
energy sector than on such policies in the water industry. As a
result, the energy sector provides helpful lessons to the water
sector in thinking about how technological innovation can
be advanced. Many ideas for increasing innovation within
the electric power sector have fallen short of their potential,
which also offers important caveats about efforts, such as in
this paper, to outline an innovation strategy for water.
The two sectors, however, differ in some important traits,
including the nature of ownership. As noted already, water
suppliers in the United States are overwhelmingly dominated
by publicly owned utilities, also known as state-owned
enterprises (SOEs), with investor-owned public utilities
supplying only a small fraction of the country’s water.2 In
contrast, investor-owned utilities dominate in the energy
sector (Besant-Jones 2006).
The similarities between the sectors are critical to
understanding the lessons that water can learn from energy.
The distribution and use cycles for both sectors depend on
large-scale and capital-intensive infrastructures and complex
governance models. Both involve high barriers to entry, which
make segments of each industry prone to natural monopoly
and low levels of competition. Both sectors also directly
interface with consumers, providing services that are vital to
individual, social, and economic well-being and, as a result,
are often politicized. Both sectors are highly regulated and
In some states, private competitive firms also play a role in
the supply, transmission, and retailing of electricity, doing
business alongside large, regulated utilities. While the
electricity distribution system (the long networks of wires
and transformers that link individual firms and households
to the grid) remains a natural monopoly, many other services
of the electric power industry have been unbundled from
the monopoly and are now provided by competitive firms.
In much of the United States competitive firms engage in
the wholesale generation of electric power. In parts of the
country, notably the regional transmission organization of the
FIGURE 2.
Comparison of U.S. Patents Filed under the Patent Cooperation Treaty for Clean Energy and
Water Purification, 1999–2011
2,500
Number of patents
2,000
1,500
1,000
500
0
1999
2000
2001
2002
2003
2004
Clean energy
2005
2006
2007
2008
2009
2010
2011
Water purification
Source: Organisation for Economic Co-operation and Development (OECD) 2014.
Note: Clean energy = biomass generation + energy efficiency + energy storage + geothermal + hydro & marine power + solar + wind; and water purification is the primary contributor to patent
filings in the water sector.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
9
Northeastern United States, power lines are also competitive.
In those settings, markets are used to encourage investment
and operation of power lines as well as bulk power generation.
In a few states, such as Texas, the open retailing of electricity
has also been tried, although that part of the industry remains
generally uncompetitive because consumers have not been
particularly responsive to electricity retail competition.
Relative to the energy sector, there is a dearth of competition
in the water sector. While private firms sometimes construct
infrastructure or undertake particular operations in
partnership with SOEs (e.g., the construction and operation
of recycling or desalination plants), the role of those firms is
highly circumscribed compared to the energy sector.
The two industries also differ in the geographic scale of
attention they receive. Water is a local resource and its
availability is subject to local climatic variability, patterns, and
geographical realities. Most debates over water policy occur
locally or at the state level with the exception of water quality.
10 The Path to Water Innovation
Power availability and supply, however, depend on regional,
national, and international markets, and therefore sit high in
national and international policy priority lists.
For these and other reasons discussed later, the water and
energy sectors have followed significantly different paths of
innovation. Using the numbers of patents filed in each sector
as an indicator, the clean energy sector has exhibited a much
higher rate of innovation over the past decade (figure 2).3 This
high level of innovation in the clean energy sector has been
partly the result of strong policy drivers for alternative energy,
including renewable power coupled to energy storage systems.
Such drivers include state mandates to increase the supply of
solar, wind, geothermal and other renewable energy supplies,
as well as federal and state financial incentives. Without such
policies the marketplace on its own probably would not have
adopted such technologies at scale, especially after the middle
of the 2000s, when the revolution in horizontal drilling and
hydraulic fracturing drove the price of natural gas (and thus
the marginal price of electricity) to low levels.
Chapter 3: State of Innovation in the Water Sector
T
he United States has the largest water market in the
world (figure 3); it is also growing rapidly (Global
Water Intelligence 2011; White et al. 2010). The global
water market includes both water and wastewater sectors. Its
budget is divided into capital expenditures, which cover capital
spending on facility expansion and/or repair; and operation
expenditures, which cover the cost of the cleaning, distribution,
and collection of water and wastewater (White et al. 2010).
Globally, capital expenditures constitute between 35 and 45
percent of the water industry’s expenses (White et al. 2010).
According to the EPA (2006), about 53 percent of the water
sector’s capital spending goes to system expansion, followed by
37 percent for replacing existing infrastructure and 10 percent
for compliance. While capital expenditures do not necessarily
involve new technologies, new capital investment provides
an opportunity for the installation of new technologies,
especially in a country such as the United States with a rapid
water market growth rate. Unfortunately, this opportunity has
not translated into rates of innovation comparable to those in
the electricity and clean energy sectors.
INNOVATION FRONTIERS IN THE WATER SECTOR
The ultimate goals of the water sector are to provide
customers with reliable and safe water supplies and to dispose
of wastewater safely and in compliance with water quality
regulations. Several assumptions historically guided water
managers in meeting these goals. First, water managers
assumed that demand for fresh water would increase with
population and that the only way to ensure a balance between
supply and demand was to find new sources of supply. The
focus therefore was on supply enhancement rather than
demand management. Water managers, moreover, generally
looked to large-scale, centralized infrastructure projects to
increase supply, on the assumption that large-scale projects
would generate significant economies of scale and provide
greater operational flexibility (Ajami et al. 2012; Hering et al.
2013). As a result, supply enhancement often meant large dams,
FIGURE 3.
Size of the Major International Water Markets, 2010
Market size (in billions of dollars)
120
100
80
60
40
20
0
United
States
Japan
China
Germany
France
Australia
Brazil
India
Source: Global Water Intelligence 2010.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
11
reservoirs, aqueducts, and water and wastewater treatment
plants. Finally, while water managers in the Western United
States worried about short-term droughts, they assumed that
long-term conditions would remain relatively static; that is,
they assumed that, if they designed water systems to meet
current hydrologic conditions, those systems would also meet
future conditions. Eastern water managers often discounted
the risk of even short-term droughts.
Water managers are rethinking all these assumptions, and
the new waterscape has opened up opportunities for a variety
of new technologies. Rather than relying only on supply
enhancement, water managers now are placing increasing
emphasis on demand management. Studies demonstrate that
new technologies, coupled with incentives and education, can
greatly reduce water use. As a result, there is increasing interest
in technologies that are more water efficient and in technologies
that can help encourage greater conservation among consumers.
Finally, large-scale, centralized infrastructure projects are
revealing a number of weaknesses. As energy costs rise, the
expense of moving water tremendous distances and treating it
has generated considerable concern. Because of the large amount
of water and number of customers involved in large-scale
projects, threats to such projects—whether from environmental
regulations, earthquakes, climate change, or other challenges—
have been magnified. As a result, there is increasing interest in
smaller-scale, decentralized sources of water supply.
Three categories of innovative technology are of particular
interest today:
1.Supply enhancement. As noted, the historically
dominant strategy to meet water demand has been supply
enhancement. Despite improvements in conservation
and water-use efficiency, supply enhancement remains an
important focus of water managers today. Water managers,
however,
are
increasingly
interested in technologies that
promise more-drought-resistant
water supplies, such as reclaimed
water or desalination; or that
can reduce energy use, such
as recycling technologies that
extract significant energy from
wastewater. Water managers also
are interested in technologies that
allow more-localized resource
enhancement strategies, such
as rainwater and storm water
capture, and small-scale water
reclamation.
Extreme climatic events such as floods
and droughts are testing the current
resilience of many water systems, revealing
their deficiencies and inefficiencies.
Hydrology, climatology, and geographic realities also have
begun to undermine the view that long-term water conditions
are largely static. Extreme climatic events such as floods
and droughts are testing the current resilience of many
water systems, revealing their deficiencies and inefficiencies.
Climate change is also undermining long-term water supplies
and the long-time assumptions of many water managers. As a
result, water managers are looking for new technologies and
approaches that are more resilient to change.
12 The Path to Water Innovation
2.Demand management. As
the focus of water managers shifts
from supply enhancement to
demand management, demand
is increasing for technologies that
encourage or enable water-use
efficiency (i.e., achieving the same
goal with less water) or water conservation (i.e., reducing
water-consumptive activities). Such technologies can reduce
the need for new supplies, increase water reliability, and
decrease the costs and pollution associated with wastewater
disposal. Examples range from water-efficient appliances to
drip irrigation to smart irrigation controllers. Technologies
that encourage behavioral change by water users, such as
smart meters that enable water consumers to get a better
real-time sense of their water usage, also have begun to play
a bigger role in the water sector.
3. Governance improvement. New technologies also promise
to improve overall water governance, which is essential to
both securing access to reliable water supply and reducing
demand. A wide range of innovative techniques are available
at various scales to tackle inefficiencies in the governance
system. Smart metering and advanced data collection
methodologies, for example, can enable water utilities to
more closely and accurately measure supply and track
demand, and to identify leaks and other failures in the
distribution system so they can be corrected quickly. Tools
that enable assessment of customer behavior under various
scenarios can improve resource planning and management.
Advanced forecasting models are becoming a necessity in
making supply planning more realistic.
These three categories cover a wide variety of technological
innovations including:
• Smart water. Technologies that integrate information
technology into water accounting and management,
such as leak detection, smart water meters, and Internetbased water-use solutions and software. These innovative
solutions enable water service providers to enhance supply
and curb demand simultaneously.
• Efficiency and conservation. Technologies that enable
short- and long-term demand management in various
sectors, such as irrigation sensors, low-flow plumbing, and
water-efficient appliances.
•Purification. All the technologies that are used to purify,
filter, disinfect, and produce water of different quality for
different beneficial uses.
• Alternative sources. Technologies with the potential of
producing water from nontraditional water sources such as
desalination, rainwater or stormwater capture, and reuse
of wastewater. The largest industry sector in this category
is desalination.
• Storage (surface and ground). Technological advancement
that focuses on improving storage capacity above and
below surface.
•Groundwater. Technologies that enable water infiltration
and groundwater banking and recovery.
A variety of constituents and target markets, including
water suppliers and various user groups (e.g., industrial,
residential, commercial, and agricultural), have helped
drive water innovation. Innovative activity in each category
of solutions often corresponds with one or more target
markets. For example, the food and beverage, pharmaceutical,
and petroleum industries have helped drive two of the
most rapidly growing technological frontiers in the water
industry—desalination and water purification (White et al.
2010). Residential consumers have helped spur interest in
water-efficient appliances. Yet, despite some advancement in
various frontiers of the water sector, the rate of innovation
dissemination has been slow. We next examine the pace of
innovation in both the water and clean energy sectors.
EVALUATING PATTERNS OF INNOVATION IN WATER
AND CLEAN ENERGY
It is difficult to measure exactly the state of innovation and
the deployment of new technologies. The picture that emerges,
however, indicates that water has not enjoyed the same pace
of innovation as clean energy. This subsection examines
innovation from the perspective of (1) investment trends,
including overall patterns as well as investment by venture
capital, corporate, and public sources; and (2) patents.
Innovation Indicators: Investment Trends
We used the Cleantech i3 database to evaluate investment
trends in the clean energy and water sectors (Cleantech Group
2014). Clean energy data comprise the sum of several clean
technology subsectors in the Cleantech investment database,
including biomass generation; energy efficiency; energy storage;
smart grid; and geothermal, hydro and marine, nuclear,
solar, and wind power. Water data include smart water (smart
metering and control, smart irrigation, and contaminant
and leak detection), purification (wastewater treatment, and
disinfection), desalination, and water conservation. While
there are many ways to look at investment, the Cleantech
database is the only one that offers systematic coverage of the
technological frontier in both sectors.
Over the past decade, investments in clean energy have exceeded
those in the water sector by an order of magnitude for all
investment types, both globally and within the United States
(figure 4). In the United States, investments are dominated by
venture capital activity in both sectors, but especially in the water
sector where venture capital and corporate ventures account for
53 and 24 percent, respectively, of total investment dollars (figure
4b). By comparison, investment banking is the largest global
contributor to both clean energy and water, at 31 and 27 percent,
respectively, of total investment dollars (figure 4a).
Despite differences in the overall magnitude of investment
between clean energy and water, the relative proportion of
global investment dollars by investor type is similar for both
clean energy and water (figure 4a, pie charts). This pattern does
not hold for U.S. investments (figure 4b, pie charts); significant
clean energy investments come from all investor types, while
corporate ventures and venture capital account for over three
quarters of all water investments. Public investment in the
water sector seems to be quite insignificant (figure 4b).
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
13
The number of investment deals is another useful indicator of
innovation because it reflects the level of interest in a sector
(figure 5). Deals are divided into venture capital, public sector
(grants, contracts, and loans), investment/merchant banker,
corporate ventures, corporations, private equity, and other.
The United States accounts for approximately 50 percent of
global investment deals in both the clean energy and water
sectors, and venture capital accounts for the vast majority of
deals at both the national and global scale.
Though venture capital investments are the most frequent
form of deal, they tend to be smaller investments, especially
in the water sector. There were 4,193 venture capital deals for
clean energy, raising $20 billion at an average of $4.8 million
per deal. By contrast, 372 deals raised $800 million in venture
capital for the water sector, at an average of $2.2 million per
deal (Cleantech Group 2014).
FIGURE 4.
Sources of Investment Dollars for Global and U.S. Innovation in the Clean Energy and Water
Sectors, 2000–13
a) Global
50
U.S. dollars (in billions)
45
16% 12%
6%
40
3%
23%
35
31%
30
15% 16%
6%
Total investments
5%
20% Total investments
27%
9%
11%
25
20
15
10
5
0
Total investments
$139 billion
Capital investment
$56 billion
Total investments
$8 billion
Clean energy
Capital investment
$5 billion
Water
b) United States
4% 5%
25
U.S. dollars (in billions)
19%
20
8%
4%
15
14%
10%
15%
28%
24%
Total investments
12%
53%
2%
Total investments
2%
10
5
0
Total investments
$69 billion
Capital investment
$41 billion
Total investments
$1.5 billion
Clean energy
Venture capital
Corporation
Public sector
Private equity
Capital investment
$1.4 billion
Water
Investment/merchant banker
Other
Corporate venture
Source: Cleantech Group 2014.
Note: Clean energy = biomass generation + energy efficiency + energy storage + solar + wind + geothermal + nuclear + hydro & marine + smart grid; and water = water + wastewater.
14 The Path to Water Innovation
The number of deals and level of investment from various types
of investors are in part reflective of existing markets for the two
sectors. Unless there is a healthy market that would accept and
adopt the newly developed innovative solutions, the investors
would not have much incentive to invest in that sector. This
in a way highlights the earlier point we made about the enduser and target markets helping to create various innovative
technological solutions.
We next look in more detail at the investment trends by some
of the key investor types in the water sector in the United
States: venture capital, corporate investment (including both
corporate venture and corporate investment), and public
investment.
Venture Capital Investment
Venture capital investment is an important initial source of
financing for new companies and can be a useful indicator of
innovation level. Venture capital investment is particularly
FIGURE 5.
Number of Deals and Relative Contribution of Investment Types for Global and U.S. Innovation
in the Clean Energy and Water Sectors, 2000–13
a) Global
Number of deals
8,000
7,000
6,000
5,000
7%
6%
4%
5%
5%
8% 13%
10% 16%
3%
7%
55%
Clean energy deals
Water deals
7%
54%
4,000
3,000
2,000
1,000
0
Clean energy
Water
b) United States
Number of deals
5,000
4,000
3,000
5%
5%
3% 4%
3%
8% 10%
3%
8%
61%
Clean energy deals
8%
16%
9%
Water deals
57%
2,000
1,000
0
Clean energy
Venture capital
Corporation
Public sector
Private equity
Water
Investment/merchant banker
Other
Corporate venture
Source: Cleantech Group 2014.
Note: Clean energy = biomass generation + energy efficiency + energy storage + solar + wind + geothermal + nuclear + hydro & marine + smart grid; and water = water + wastewater.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
15
useful as a measure of high-value innovation because it is rooted
in a business model based on the philosophy of identifying
early stage investment opportunities in technologies with
potentially high returns in a short timeframe. Under this
business model, many water technologies are at a disadvantage
in competing for venture capital funds (figures 4a and 4b), due
to the risk-averse nature of the highly regulated water sector;
the technologies require long testing and review periods
before they can be adopted (Forer and Staub 2013).
The data presented here confirm this hypothesis. While
venture capital represents the largest flow of investment in the
water sector in the United States (about 53 percent; see figure
4b), it still claims a very small percentage of total Cleantech
venture investments nationwide (about 4–5 percent). U.S.
venture capital investment in water technologies, while
showing a positive trend, is still very small compared to other
sectors such as clean energy (figure 5b).
FIGURE 6.
Global and U.S. Investments in Clean Energy and Water by Venture, Corporate and
Corporate Venture, and Public Sources, 2000–13
Invested dollars (in billions)
a) Venture
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Invested dollars (in billions)
b) Corporate (solid) and corporate venture (dashed)
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Invested dollars (in billions)
c) Public
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
U.S. energy
Source: Cleantech Group 2014.
16 The Path to Water Innovation
Global energy
U.S. water
Global water
Venture capital investments in both the water and energy
sectors were relatively flat up to 2004 (figure 6a). However
venture capital investment in the clean energy sector grew
by a factor of five between 2004 and 2011. The water sector
witnessed a very small growth in venture capital investment
during those years. The growth in the clean energy sector was
partly driven by the move toward clean energy and renewable
energy portfolio standards and other more-aggressive energy
policies, which eventually created a big market opportunity in
the sector. Solar and wind power global market size has grown
on average tenfold since 2004 (figure 7) (Shahan 2011).
corporations, venture investment in water innovation has
two dimensions. First, some corporations might be seeking
to improve their own internal operations. For example, food
and beverage companies may wish to acquire new purification
systems for their processes. Second, corporations might
be looking for new market opportunities. These two goals
separate corporations from venture capitalists, as their interest
goes beyond groundbreaking technologies with potentially
high financial return. Marginal advances in technology that
could ultimately help their operational needs could be seen as
a valuable investment for corporations.
Corporate Investment
Corporations are becoming increasingly interested in
investing in innovative water supply and purification
technologies (figure 6b), as access to clean water can affect
their bottom line (Heslop and Faulkner 2013). Corporate
interest in water technologies can create target markets that
Corporate investment constitutes a significant share of overall
funding in the water sector (see figure 4). Corporations
both invest in internal R&D and provide venture capital
funds for other companies developing new technologies. For
FIGURE 7.
Number of Patents Relative to Market Size for Solar and Wind Power Industry, 2000–11
Number of patents
1,000
100
800
80
600
60
400
40
200
20
0
2000
2001
2002
2003
2004
2005
2006
Number of patents
2007
2008
2009
2010
2011
0
Market size
Number of patents
240
80
180
60
120
40
60
20
2000
2001
2002
2003
2004
2005
2006
Number of patents
2007
2008
2009
2010
2011
0
Market size (in billions of dollars)
b) Wind industry
0
Market size (in billions of dollars)
a) Solar industry
Market size
Source: Pernick, Wilder, and Winnie 2013.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
17
help drive innovation in those areas. Corporate investment
in the water sector is still lagging behind clean energy (figure
6b). Nevertheless, as water scarcity and stricter environmental
regulations affect corporations, their interest in finding
innovative solutions to meet their water demands and
maintain growth will only rise, especially in high-growth
industries such as oil and gas (Cleantech Group 2014).
Public Investment
A critical contrast between the water and clean energy sector
investment trends is the level of public money (mostly R&D
in the form of grants, contracts, and loans). According to the
Cleantech Group data (2014), in the United States the clean
energy sector has benefited from about $8 billion in public
investment over the past thirteen years, while only $28 million
in public dollars has gone to the water sector over the same
period. The level of global public investment in the water
sector is also an order of magnitude less than in the clean
energy sector (figure 6c).
Public funding has proven to be of critical importance in the
clean energy sector. None of the really big advances in the
electric power industry—such as the rise of nuclear or gas
generators—would have been possible without governmental
funding. While it is hard to analyze the counterfactual,
this story has been replicated so many times in the power
industry as well as most other industries—for example,
advanced computing (National Research Council 1999)—
that it is probably robust. The critical role of public-sector
funding, combined with the limited private-sector funding
for innovation in the water sector, is one of the major factors
behind the sluggish technological development in the U.S.
water sector.
Innovation Indicators: Patents
Patent filings are another indicator of the state of innovation in
an industry. Patents are one visible output from the innovation
process. Like the other indicators we use, patent filings are
subject to a variety of biases. Sheer spending on innovation can
raise patent numbers even without an increase in innovation
levels because organizations need to demonstrate tangible
outputs. Patents also vary in their importance. Finally, overall
patent numbers have been rising as more industrial sectors
try to emulate IP strategies long evident in pharmaceuticals
and IT (where patenting is extensive). Nonetheless, patent data
provide a useful tool to compare innovation patterns across
time, sector, and geography.
FIGURE 8.
Patent Filings with Patent Cooperation Treaty for Water Purification and Clean Energy by
Country, 1999–2011
b) Renewable and nonfossil fuels
6,000
5,000
5,000
Number of patents
6,000
4,000
3,000
2,000
3,000
2,000
0
0
Source: Organisation for Economic Co-operation and Development 2014.
The Path to Water Innovation
Japan
19
19
European Union
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
1,000
China
18 4,000
1,000
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
Number of patents
a) Water purification
South Korea
United States
Other
FIGURE 9.
Number of U.S. Patents Filed in the Clean Energy and Water Subsectors, 1999–2012
1,000
Number of patents
800
600
400
200
0
Wind
1999
2006
Solar
2000
2007
Geothermal
energy
2001
2008
Hydro &
marine
power
2002
2009
2003
2010
Biomass
generation
Energy
storage
2004
2011
2005
Energy
efficiency
1999
2006
Purification Desalination
2000
2007
2001
2008
Metering
2002
2009
2003
2010
Irrigation
2004
2011
Groundwater
2005
2012
Sources: Organisation of Economic Co-operation and Development (OECD) 2014; Foley and Lardner LLP 2012.
Note: Clean energy patent data (in blue) are filed with the Patent Cooperation Treaty and obtained from OECD (2014). Water subsector data (in green) are filed with the U.S. Patent and
Trademark Office in the U.S. Department of Commerce. Water purification data for 1999–2011 are obtained from OECD (2014); water desalination, metering, irrigation, and groundwater data for
2008–2012 are obtained from Foley and Lardner LLP (2012).
The number of clean energy patent applications (renewable and
nonfossil fuels) submitted annually increased dramatically
during the 2000s, particularly in the European Union, Japan,
and the United States (figure 8b). By contrast, the annual
number of water purification patent applications filed in these
countries has remained relatively constant (figure 8a). This is
also true for the global pattern. Although figure 8a presents
patents for water purification only, this subsector accounts for
the majority of all water patents (figure 9).
Patent activity for the clean energy and water subsectors
(figure 9) helps elucidate which technologies are driving the
most innovation. The number of patent applications in solar
technology has been the most prolific for the past decade,
which is also reflective of the market size for this technology
(figure 7). But patent activity is also substantial for a number
of other clean energy subsectors, including energy storage and
biomass generation. Patent activity in the water sector is much
less evenly distributed. The number of patent filings for water
purification technologies dominates. Desalination, metering,
irrigation, and groundwater collectively contributed fewer than
half as many patent applications in 2012. Though annual patent
filings for purification have been growing, patent activity in the
other water subsectors appears to be relatively stagnant. None
of the water subsectors has achieved the acceleration in patent
filings exhibited by most of the clean energy subsectors.
Innovative technologies do not necessarily have to be adopted
by a regulated utility or SOE to attract funding. This is true
for both the water and the energy sectors. The patent trends
observed throughout this section highlight the importance of
end-use or target markets. In general, innovative solutions such
as purification technologies that cater to an industry, especially
industries with high growth rates such as food and beverages,
pharmaceuticals, and oil and gas, have attracted more funding
and investment sources and seen a growing number of patent
applications.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
19
Chapter 4: Explaining Patterns of Innovation
T
raditionally, change in the water sector has been reactive,
often driven by operational necessity; natural disasters
such as floods, fires, and droughts; economic realities;
environmental regulations; and technological advancement in
other sectors such as energy (Forer and Staub 2013). This often
has led to adoption of less-innovative, mostly off-the-shelf and
established solutions. Here we examine some of the barriers to
current and future innovation in the water sector.
Some factors cannot be addressed by new government
policies. Innate conservatism in the water industry is one such
factor that hinders fundamental innovation. The fundamental
importance of water to life and to all sectors of the economy,
combined with the potential for water impurities to lead to
illness and even death, means that public health concerns
often trump virtually any other consideration, including
cost. More than perhaps any other sector, water suppliers are
reticent to use new technologies that have not been carefully
tested at multiple scales and found to present no risk to the
safety of water supplies.
As noted earlier, fragmentation of the water industry also
poses an obstacle to the development and adoption of new
technologies. Water suppliers in many parts of the United
States are relatively small, making it more difficult for them
to evaluate, test, or afford new technologies (Roy et al. 2008).
The fragmentation of water supply also slows the diffusion
of new technologies through the industry.4 Fragmentation
also can separate costs and gains. For example, adoption of
recycling, desalination, or other technologies designed to
produce additional water might benefit a region as a whole by
diversifying its water supply, but pose a cost only to the local
supplier (Kiparsky et al. 2013).
Water systems, for both freshwater delivery and wastewater
disposal, are generally complex engineered systems, consisting
of large-scale infrastructure (dams, reservoirs, aqueducts,
pipelines, and treatment facilities) with long lifetimes. This
infrastructure lasts for decades or longer, and has biased the
water industry toward the adoption of incremental upgrades
rather than toward more-innovative and groundbreaking
technologies. The large-scale delivery of recycled water in
developed areas, for example, requires new underground
piping systems, which can be prohibitively expensive and
20 The Path to Water Innovation
disruptive to install when not done in connection with the
replacement of existing piping systems. Yet most piping
systems can last fifty years or longer. Even when individual
elements of a water system need replacement, the rest of
the system remains functional, making it more likely that
the owner will simply replace the worn element rather than
fundamentally rethink or replace the water system as a whole.
New technologies, moreover, might not meet the engineering
standards of the existing system. Finally, the expense and long
lives of water systems generate sizable, long-term debt, which
further commits organizations to existing technologies.
These factors—a risk-averse, conservative business climate;
the typically long life expectancy, size, and complexity of
water systems; and water systems fragmented by geography
and function—help explain the lack of innovation in the
water sector, but are not readily addressed by policy reforms.
We therefore focus our policy proposals on three additional
challenges that inhibit innovation, but that can be addressed
through improved public policies—current water pricing
practices, regulations, and lack of access to capital.
PRICING PRACTICES
The pricing of water presents a significant obstacle to
innovation in the water sector. Water in the United States is
generally underpriced and does not reflect the true economic
cost of water to society. Many water systems subsidize the cost
of extracting, conveying, purifying, and distributing water.
Water suppliers also do not always charge prices adequate
to replace their infrastructure as it ages. Finally, water prices
never reflect the opportunity cost of the water supplied or the
environmental externalities involved in furnishing the water.
The extraction of water from surface waterways inevitably has
a cost—in reduced recreational opportunities, harm to fish, or
other physical or biological harm. Pumping of groundwater
also can impact the environment, and over-pumping can cause
subsidence and increase energy use. Water prices, however, do
not reflect these costs. While water rates in the United States
have been rising in recent years (Global Water Intelligence
2012), the average cost of water in the United States is still one
of the lowest compared to other developed countries (figure
10; Forer and Staub 2013).
FIGURE 10.
Tariff Price and Domestic Use per Capita, 2012
Tariff price (dollars per one thousand gallons)
40
35
Denmark
30
25
Australia
Germany
20
France
United Kingdom
15
10
5
China
0
United States
Japan
0
20
Russia
Mexico
India
40
60
80
100
120
140
160
180
Domestic use (gallons per person per day)
Source: Standard & Poor’s 2012.
Note: The tariff price includes water and wastewater tariffs and it is the average price among cities in that country.
The pricing of water in the United States affects innovation
in several ways. First, it reduces the revenue available to
water suppliers to invest in innovation. The ratio of capital
investment to collected revenue for water supplies compared
to other utilities in the United States (figure 11) illustrates how
underpriced water is in this country considering its capital
intensity. This often leads to a gap between revenue collected
from customers and the total costs to operate these systems,
leaving limited options to pursue innovation.
Inadequate pricing can create a vicious cycle where water
suppliers are unable to replace existing infrastructure, which
can further reduce their revenues. According to the EPA
(2013), about 16 percent of the treated water in the United
States is lost to leaky pipes and system inefficiencies. This
translates to 7 billion gallons of clean water per day that is
produced without generating any revenue for the water
service providers (Maxwell 2013). Metering inaccuracies
and unauthorized consumption also leads to revenue loss.
Overall, about 30 percent of the water in the United States
falls under the category of nonrevenue water, meaning water
that has been extracted, treated, and distributed, but that has
never generated any revenue because it has been lost to leaks,
metering inaccuracies, or the like (Haji and Yolles 2013). This
loss of revenue further jeopardizes recovery of the cost of
service. These combined factors have led to shrinking capital
and funding sources for future water projects, restraining
access to capital and increasing the cost of financing new
infrastructure (Ajami et al. 2012; Donnelly, Christian-Smith,
and Cooley 2013).
Second, the underpricing of water can bias the decisions of water
managers on whether to invest in innovative technologies. For
example, as noted earlier the extraction of water from a river
or stream can have significant environmental costs. Because
prices do not reflect such costs, however, analyses to decide
whether to extract additional water for a growing city or to
invest instead in water recycling and reuse, which might not
impose the same environmental costs, may incorrectly suggest
that water extraction is the better approach. The problem is
much the same as the failure to account for the costs of carbon
emissions in energy decisions.
Third, the underpricing of water can undercut incentives that
water users would otherwise have to invest in new technologies
to reduce water use. Further reducing incentives, some water
suppliers in the United States still do not meter their water.
Those that do meter their water engage in average-cost pricing,
where all water users in their jurisdiction pay the same price
for each unit of water. New users therefore do not confront the
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
21
FIGURE 11.
Relative Capital Investment to Revenue Ratio for Several Utility Services
Relative capital to revenue ratio
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
Diversified
telecommunications
Local exchange
telecommunications
Gas pipelines
Gas distribution
Electric
Water
Source: Global Water Intelligence 2010.
full marginal cost of the water that must be brought into the
region to meet their needs, further undermining incentives
for users to invest in water-efficiency technologies.
The energy sector demonstrates the importance of full-cost
pricing. Prices have had a huge impact on the adoption of
renewable energy technology as well as technologies that
are more energy efficient. States with the highest electricity
costs—such as Hawaii and California—have seen the most
active programs to advance wind, solar, and other forms of
renewable electricity. Prices alone have not been sufficient
to encourage massive investment, but prices in combination
with policy supports have had a large impact. Given the higher
prices, the size of needed regulatory and subsidy programs also
have been more manageable politically. Some analysts now see
even residential solar systems—among the more expensive
forms of renewable power—becoming cost effective in Hawaii
and California without policy support in the next few years
(Byrd et al. 2014). High prices along with policy programs also
have encouraged conservation and efficiency—which helps to
explain why California’s per capita electricity consumption
has been flat since the early 1970s even as consumption in the
rest of the nation has increased (Natural Resources Defense
Council 2013).
REGULATIONS
Regulations can both help and hinder technological innovation.
In both the energy and the water sectors, new regulations have
often driven technological innovation. Regulations also can
help reinforce existing technological change, encouraging
broad diffusion of an innovative technology. Unfortunately,
22 The Path to Water Innovation
however, regulations can also serve as a barrier to innovation
and lock organizations into existing technology. Table 1
presents a series of elucidatory examples that demonstrate
how regulations can both facilitate and obstruct innovation
in water recycling. The water regulatory drivers currently
in use show the variety of approaches that governments
can take to encourage the adoption of new water-recycling
technology. No studies exist on the impact of these varied
regulations on innovation in recycling, but they are likely to
encourage innovation by (1) ensuring a significant market for
recycling technology, (2) encouraging the diffusion of such
technology, (3) enabling the refinement and improvement of
recycling technology through actual use, and (4) driving the
development of less-expensive recycling technologies.
Regulations can encourage innovation through different
mechanisms. In some cases, regulations directly encourage
the invention or adoption of new technologies that can meet
the new regulatory requirements. In other cases, regulations
can encourage innovation by banning or discouraging the
use of existing technologies. Regulations that set performance
standards that require new technologies (called technologyforcing regulations) will generally encourage greater
innovation than regulations that simply require the use of a
specific technology or general category of technologies (or
technology mandates).
Perhaps the best example of technology-forcing regulation is the
federal Clean Water Act. Under this Act, the EPA determines
the best technology available, based on various technological
and economic considerations that vary across types of point
TABLE 1.
Regulatory Drivers and Barriers to Adoption of Water-Recycling Innovations
Regulatory Drivers
Examples
Numerous jurisdictions require wastewater districts to examine
Las Vegas, Nevada requires large-scale irrigators to use recycled water
opportunities for recycling or directly require types of water consumers
where available.
to use recycled water.
Sydney, Australia requires new subdivisions to install dual piping
systems that can deliver high volumes of recycled water.
Some governments force their offices to serve as early adopters of
California requires both its Department of General Services and its
technological inventions.
Department of Transportation to install pipes for recycled water in
areas where recycled water will become available within a decade.
Las Vegas, Nevada prohibits the use of potable water for artificial or
created lakes.
Regulatory relief encourages the adoption of recycling technology.
In Austin, Texas city-adopted water conservation requirements do not
apply to the use of recycled water.
The City of Cerritos, California exempts irrigated landscaping from
conservation requirements where recycled water is used.
St. Petersburg, Florida exempts recycled water from drought
restrictions.
Regulatory Barriers
Examples
Some jurisdictions ban recycling entirely without legitimate concern.
The California Department of Health Services bans the retrofitting of
buildings for the use of recycled water.
More commonly, jurisdictions require costly permitting and inspection
In California industrial plants that use recycled water must be
requirements, or impose expensive protective measures even in
inspected by the Department of Health Services, even though human
situations where the use of recycled water is clearly safe.
contact with such water is remote to nonexistent.
Taking an approach that is more favorable to the adoption of new
recycling technology, Arizona requires state permits where recycled
water is used on crops but not when it is used in industrial processes.
California requires the use of dual pumping where recycled water is
used in a building solely for toilet flushing.
Source: Baker and McKenzie LLP 2008.
sources and pollutants. The EPA then requires companies to
meet effluent standards based on this technology. Existing
sources of water pollution, for example, must use the “best
available technology economically achievable” (Federal Water
Pollution Control Act 2002, p. 119, sec. 307), which is known
as the BAT standard, to reduce toxic and nonconventional
pollutants, or meet an effluent standard equivalent to
what BAT technology would achieve. By imposing a BAT
standard, the EPA encourages the development of better
and more economically achievable technology. To ensure
that the incentive continues over time, the EPA periodically
reconsiders the BAT standard. By converting BAT technology
into an effluent standard, rather than requiring that companies
use the BAT technology itself, the federal government also
provides companies with the flexibility of discovering other,
even-less-expensive means of achieving the same result as
the BAT technology—reducing the economic impact of the
regulation and further encouraging new innovation, while
not undermining effluent reductions.
Technology-forcing regulations have the ability to help drive
down the cost of innovative technologies through shared
experience and economies of scale. One study that tracked
patenting related to scrubbers showed that the most aggressive
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
23
FIGURE 12.
Importance of Industry Issues, 2012
Aging water and sewer infrastructure
Managing capital costs
Funding or availability of capital
Energy cost
Increasing/expanding regulation
Treatment technology
Aging workforce
Chemical costs
Information technology
Security problem
0
1
2
3
4
5
Source: Black and Veatch Corporation 2012.
Note: Survey participants were asked to rate the importance of each of the above referenced issues to the water industry based on a scale of 1 to 5, where 1 indicates “very unimportant” and 5
indicates “very important.” The results above show the average response for each issue.
period of patenting came when regulated utilities were under
technology-forcing regulations adopted by the EPA. During
other periods, when incentives were market-based, firms
engaged in less innovation (Taylor, Rubin, and Hounshell 2003).
Technology-forcing regulations are most effective when
enacted in conjunction with other enabling actions, such as
research support and information sharing. One of the beststudied examples—the sulfur dioxide control provisions of
the 1990 Clean Air Act Amendments—demonstrated that
sulfur dioxide provisions in conjunction with government
research support encouraged innovation faster than did either
measure by itself. Additionally, complementary technological
conferences convened by the EPA helped promote knowledge
diffusion, and thus the widespread adoption of new
technologies.
The efficacy of regulation can depend on the industry and
companies involved. Industries that are more mature and
protected tend to resist change and often fight regulatory
requirements that would require innovation. In response,
governments often delay or soften initial regulatory standards.
By contrast, smaller firms, as well as new entrants to a market,
are generally more receptive to regulatory-driven innovation.
One mechanism for dealing with the opposition of mature
or protected industries is to provide for innovation waivers,
in which the government waives technological standards in
return for a company’s commitment to develop and test new
technological options.
Rate regulation by the Public Utility Commission also can
affect the level of innovation by utilities. Although it has often
24 The Path to Water Innovation
been assumed that competition encourages innovation, some of
the most highly regulated firms in the power sector are also the
most innovative—in part because direct regulation allows them
to manage the risks of innovation. During the most aggressive
period of competition in the power supply industry, which began
in the late 1990s, the incentives for marginal improvements in
performance were very strong. But disruptive innovation, for
the most part, has come from regulated or state-owned firms
that can more readily absorb risk.
Applying this lesson to today’s advanced coal technologies
reveals what might be called the regulator’s dilemma. The
standard view is that regulated firms are not innovative, but
that private, competitive firms are. But in power the main
effect of creating the very market for those competitive
firms has been to undercut innovation. That is exactly the
pattern of investment that is evident today in advanced coalfired power plants that use integrated gasification combined
cycle and carbon capture and storage. These two processes
are widely seen as critical to cutting emissions of carbon
dioxide, the leading cause of global warming. As yet, however,
essentially no power companies that operate as merchants
in fully competitive markets—in contrast with utilities
that are regulated as monopolies and thus have relatively
assured customers, prices, and rates of return—invest in this
technology. Within the United States the two power plants
that are exploring these technologies—one in Indiana and one
in Mississippi—are being built by regulated utilities that are
passing most of the cost (and some of the cost overruns) on to
customers with the blessing of regulators.
Regulation can, however, sometimes create a barrier to
new innovation. Regulatory regimes often develop around
existing technologies and may clash with the characteristics
of new technologies. In some cases, manufacturers of existing
technologies, or other vested interests, may use regulations
as a market barrier. Even where regulations are justified, new
technologies often face administrative costs stemming from
the need for permits or other forms of regulatory approval
that existing technologies do not face. Innovative technologies
are novel by definition, and governmental officials addressing
new technology without the benefit of experience can
promulgate regulations that are at best redundant, and at
worst inconsistent.
LACK OF ACCESS TO CAPITAL
For several reasons, the water sector is also facing challenges
in its access to capital. Operation and maintenance costs are
rising (Leurig 2012). At the same time, revenue is declining
in response to reduced demand from conservation efforts and
to leaks and inefficiencies in the water delivery system. These
factors, in addition to inadequate pricing, have led to financial
instability in the industry, jeopardizing the industry’s credit
quality and ultimately affecting its access to affordable capital.
The lack of access to capital has introduced another barrier to
seeking and embracing innovation. In a recent national survey
done by Black and Veatch Corporation (2012), water service
providers identified the availability of capital as one of the top
three issues most important to the industry (figure 12).
The large role that the public sector plays in the water industry
also inhibits the raising of capital. Unlike private companies,
public entities such as cities and water districts rely on high-
quality, low-yield bond funding. The accrued bond-related
debt plus interest must be paid back out of generated revenue
or from a locality’s general fund. However, rising costs and
declining revenue have jeopardized the market’s evaluation
of public water systems as low-risk investment, in some cases
affecting their access to cheap capital and financing options
(Forer and Staub 2013; Leurig 2012).
In addition, bond pricing and rating depend on the risks
associated with a project. As a result, public entities often
are unable to finance technologies that promise higher but
riskier rates of return. For example, where the profitability
of desalination technology depends on future water supply
limitations and on future increases in the cost of other watersupply options, governmental entities may find it difficult to
raise needed funding to build the desalination plant today
(Kiparsky et al. 2013).
The financial stability and credit quality of a water organization
are critical to capital availabilities. As one example, the West
Basin Municipal Water District largely financed its innovative
recycled water project, which provides recycled water in
various qualities tailored to specific end-use (e.g., agricultural
or industrial use), through the issuance of bonds and some
federal and state grants (Lazarova et al. 2013). The water
district would not have been able to access affordable capital
(with a low interest rate) and finance the project if it had
not demonstrated its good credit rating and stable cash flow
projection (California State Auditor 2001). For the reasons
discussed, many water utilities today are not able to obtain
the same access to affordable capital unless they improve their
financial standing.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
25
Chapter 5: Infusing Innovation into the Water Sector
A
lthough innovation is occurring throughout the U.S.
water industry and throughout the water distribution
and use cycles, it is incremental, fragmented, and
focused primarily on water treatment and purification. Three
sets of reforms are particularly important in order to promote
increased water innovation. These reforms are proposed in
light of the challenges, as laid out in “Explaining Patterns
of Innovation” above, including the disconnect between
the market price of water and the cost of supplying water, a
regulatory framework that at times can hinder innovation, and
a lack of public-sector financing for innovation. Our proposals
are designed to overcome these barriers.
IMPROVE WATER PRICING POLICIES
We call for three targeted reforms to water pricing to
strengthen innovation in the water sector. First, we advocate
pricing schemes that capture the full cost of delivering water
and that ensure the financial health of water suppliers. Second,
we call for consumers of water to face the total marginal cost
of each unit of water consumed, including any associated
externalities. Finally, we propose that utility revenue be
decoupled from the quantity of water sold, with rebates or
surcharges compensating for any difference between projected
and realized sales.
Rate reform in the water sector can play an important role in
promoting new water technologies. Current pricing policies
often fall short of capturing the full cost of water provision and
wastewater treatment. Low water prices decrease the funding
that water utilities have available to invest in innovation. They
also undercut the economic incentives that water users have
to invest in new conservation technology. Not surprisingly,
studies have found that higher energy prices encourage greater
investment by energy users in conservation technologies (e.g.,
Popp 2001). As shown in figure 13, electricity prices from 1999
to 2011 are strongly correlated with the number of clean energy
patents issued.
FIGURE 13.
10.5
2,800
10.0
2,400
9.5
2,000
9.0
1,600
8.5
1,200
8.0
800
7.5
400
7.0
2001
2002
2003
2004
2005
Average price of electricity
2006
2007
The Path to Water Innovation
2009
Number of clean energy patents
Sources: Energy Information Administration 2014; Organisation for Economic Co-operation and Development 2014.
26 2008
2010
2011
0
Number of clean energy patents
Average annual retail price of electricity
(cents per kilowatt hour)
Number of Clean Energy Patents and Price of Electricity, 2001–11
Water and wastewater utilities therefore should ensure fullcost pricing of their services. Water and wastewater rates
should recover all the costs of the utilities’ services, including
the costs of replacing infrastructure over time and needed
R&D. Consumers are accustomed to low water rates and
frequently protest rate hikes (Apple Valley News 2014; Webb
2011). Nonetheless, it is important that water and wastewater
utilities take steps in this direction. Absent rate reform, many
utilities will remain financially incapable of evaluating,
testing, and adopting new technologies.
Water utilities also should make water consumers confront the
marginal cost of their water usage to give them an incentive
to adopt efficient conservation technologies that can reduce
that usage. Water utilities that charge flat fees for water, under
which everyone pays the same price no matter how much water
is used, should move to a metered
pricing structure. Water utilities
that charge a uniform unit rate
to all consumers should move
to a tiered (or block-rate) pricing
structure that charges more per
unit as overall consumption
levels rise. Under tiered systems,
consumers pay a reduced rate
for a basic supply of water, but
then face increasingly high rates
as their overall consumption
increases.
gently increasing tiers that fail to create effective conservation
incentives.
Ideally, water rates also should reflect differences in the
environmental and other impacts—or externalities—of
various water supplies (Forer and Staub 2013). For example,
as discussed earlier, extracting water from a river or lake
frequently impacts fish and recreational opportunities. If the
price of water does not reflect the cost of such externalities,
water utilities will be less inclined to invest in new technologies,
such as water recycling, that do not have such impacts. Yet
states currently charge water utilities only a nominal fee,
if any, for extracting water from a river or lake. As a result,
water consumers pay for the operational and financial costs
of the water they use, but not the environmental, recreational,
and other opportunity costs. Since 1988 some European
Water utilities should make water
consumers confront the marginal cost
of their water usage to give them an
incentive to adopt efficient conservation
Many water utilities in the
United States still charge
uniform unit rates. In recent
years, a growing number of
water suppliers have adopted
tiered systems. Successful tiered
pricing structures apply to all
water consumers, including
industrial users; have low
threshold consumption levels for the higher tiers; and charge
sharply increasing rates for each succeeding tier. In 1990 the
Irvine Ranch Water District in California became one of the
first water suppliers to adopt a tiered rate structure. Irvine
employs five tiers, and the cost per unit of water in the top
tier, into which about 6 percent of consumers fall, is eight
times the standard cost of the water in the lowest tier. Boulder,
Colorado, adopted a tiered rate structure in 2007; under its
system, the highest tier is five times the standard rate. In both
regions, tiered pricing has encouraged consumers to invest
in water-saving technologies. Not all water utilities, however,
currently use tiered pricing systems. Moreover, those that do
use them often have high volume thresholds for the higher
tiers, so that few consumers fall into those tiers, or they have
technologies that can reduce that usage.
jurisdictions have imposed taxes on water extraction to reflect
the accompanying externalities. These taxes both encourage
water suppliers to look for alternative technologies and
provide funding to support technological R&D.
As in most industries, revenues in the water sector are the
product of the price per unit and the sales volume. This
coupling of water revenues to the volume of water sold can
discourage investments in new technologies. Because water
supply systems have high fixed costs, utilities can fail to earn
enough revenue to recover their costs if water sales drop.
The resulting revenue instability can raise the cost of capital
and thereby deter investments in new technology. Because
utilities have an incentive to sell as much water as possible (a
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
27
BOX 1.
California’s Decoupling Experience
In 2006 California became the first state to try decoupling water rates (California Public Utility Commission 2008).
California’s pilot program applies to investor-owned utilities with more than 10,000 customers; together, these utilities
furnish 95 percent of the water supplied by private companies in the state. Under the pilot program, utilities can use a
water rate adjustment mechanism to recover revenues lost because of reduced sales from conservation or other causes. This
mechanism reduces utilities’ risk of falling revenue due to conservation, recession, or high precipitation and, as a result,
both helps strengthen access to capital and lowers its cost.
phenomenon known as throughput incentive), they are also
less likely to adopt or promote conservation technologies.
Water utilities can address this problem by “decoupling” their
revenues from the quantity of water sold. Decoupling can
be accomplished in several ways. Under the most common
approach, utilities are guaranteed a target revenue based on
expected sales and costs and use a true-up mechanism to
periodically adjust their rates to ensure that actual revenue
over time is equal to target revenue (Donnelly, ChristitanSmith, and Cooley 2013). Utilities therefore recover their
target revenues regardless of actual sales. The regulatory body
overseeing a utility sets the initial rate based on best estimates
of sales and revenue. If sales turn out to be below the target,
the utility is allowed to adjust its rates in the upcoming period
to recover the lost revenue. If sales are above the target, the
utility rebates the excess profits to its consumers through
reduced rates. Under decoupling, water consumers still pay
per unit of water used, thus encouraging them to conserve,
but utilities enjoy more-stable revenues and are not dependent
on expected sales.
Decoupling water rates promote new technologies in several
ways:
• Water utilities no longer have an incentive to maximize the
sale of water and therefore discourage the adoption of new
conservation technologies.
• Water utilities have increased financial sustainability and
therefore greater ability to invest in new technologies.
• Utilities have enhanced long-term access to capital.
In the energy sector, approximately half the states and the
District of Columbia have decoupled rates for energy use
(Robertson 2013). As predicted, when rates are decoupled,
energy utilities generally enjoy greater financial stability and
lower costs of capital. When used in combination with various
conservation programs, decoupling also makes it more likely
that utilities will invest in and encourage conservation
technologies.
28 The Path to Water Innovation
To date, however, only a handful of states, including Arizona,
California, Connecticut, Nevada, and New York, have
experimented with decoupled water rates (Wharton, Villadsen,
and Bishop 2013). These experiments, moreover, have been
limited to water rates charged by investor-owned utilities. In
California, for example, the Public Utility Commission took
the lead and ordered decoupled rates for the investor-owned
utilities that it oversees (see box 1). As explained above, such
investor-owned utilities furnish water to only about a fifth of
domestic users in the United States.
There is no reason why public water suppliers cannot also
decouple their rates. Decoupling in the energy sector also
historically was limited to investor-owned utilities. Yet earlier
this year two public electricity providers in California—the
Los Angeles Department of Water and Power and Glendale
Water and Power—decoupled their electricity rates. In both
cases decoupling was accomplished through a mechanism
very similar to that employed for investor-owned utilities;
the only difference was that the city council, rather than the
state utility commission, adopted and implemented the policy.
Both utilities have reported that they are so pleased with the
results that they are now considering decoupling their water
rates as well (Xue 2014).
DEVELOP INNOVATION-FRIENDLY REGULATION
Regulation in the water sector can both promote and inhibit
innovation. To ease the negative impact of regulations that
restrain the water sector, we recommend a two-pronged
approach to regulatory reform. First, we propose a statewide
review of regulatory practices along several key criteria.
Second, we propose that select states create offices of water
innovation to better coordinate innovation efforts and
recommend and oversee regulatory reforms to the state’s
water sector.
Regulations today can pose a major barrier to innovation.
Regulations often have developed around existing technologies
and may be insufficiently adaptive to new innovations.
Regulations, moreover, are often fragmented geographically
(with local regulations, e.g., sometimes blocking technologies
that are permitted or even encouraged by state law) and by
issue (with health and safety regulations, e.g., sometimes
conflicting with water supply goals). In addition, unlike the
technology-forcing incentives of the Clean Water Act, few
state or other federal laws encourage new innovations in the
production or delivery of water supplies or in the reduction of
energy used in water systems.
We recommend that each state conduct a systematic review
of its regulatory practices relating to the water sector. Each
review should be conducted along the following parameters:
• State legislators and regulators should avoid geographically
inconsistent regulations. New technologies can confront
a baffling assortment of local regulations that are all too
often inconsistent with each other. Where there is no need
for local variation, states should set uniform statewide
regulations. Such regulations should preempt inconsistent
local regulations. States also should seek to coordinate their
regulations with neighboring jurisdictions. Companies
may be less likely to pursue innovation if they must meet
different standards in every jurisdiction. Countries in the
European Union have sought to adopt uniform rules that
provide legal consistency and encourage the development
and adoption of new technologies.
• Legislators and regulators also should consider crosssector impacts when adopting new regulations. Wherever
possible, new rules should coordinate across sectors (e.g.,
water and wastewater, or water and energy) to ensure
consistent treatment of new technologies and reduce
unnecessary obstacles. Regulation, in short, should provide
for cross-sectoral consistency.
• State regulations should provide sufficient flexibility to
avoid blocking the timely adoption of new and innovative
technologies. In particular, regulations where possible should
be based on performance, rather than on the adoption of
particular technologies or on the meeting of specific criteria
that are technology-specific and not needed to ensure the
achievement of the ultimate performance goals.
•State legislators and regulators should consider the
appropriateness of rules that encourage the adoption of
new technologies. Renewable energy technologies have
benefitted from technology-forcing regulations and goals,
such as renewable performance standards that require
utilities to furnish a specific percentage of their electricity
through renewable technologies. Some states and local
jurisdictions have similarly encouraged the adoption of
recycling technology by requiring recycled water to be
used in certain circumstances (or similarly banning the
use of freshwater extracted directly from rivers or lakes).
Other states have encouraged the use of new technologies
by requiring water and wastewater utilities to evaluate the
potential adoption of such technologies.
The goal of the review would be the development of
recommendations for needed regulatory changes, whether
new regulations or the elimination or modification of existing
regulations. This study could be conducted by the principal
state water agency or by an interagency review team.
Once existing regulations have been reviewed and revised,
legislators and regulatory agencies should ensure that
future regulatory actions are consistent with technological
innovation. Before adopting new regulations, key decision
makers should investigate what technologies might be affected
and whether any resulting deterrence is justified. Once
again, states’ existing water agencies should assist in such
preregulatory reviews.
A second prong of our proposed regulatory reform calls for
some states to establish an office of water resources innovation
and development (that we will call an innovation office), tasked
both with developing a vision for the role of technological and
managerial innovation in driving sustainable water resource
management and with promoting policies to implement that
vision. A major area of focus would be regulatory support.
Ultimately, all states may wish to establish such offices.
However, initially those states with the greatest opportunities
and interest could take the lead.
The process for evaluating and creating such an office will
vary from state to state depending on each state’s existing
water governance system. Under one approach the legislature
or governor could first create an independent commission
or task force comprising policymakers, academic experts,
and major stakeholders to undertake a series of studies
examining various water challenges and opportunities in
the state, auditing the overall state of innovation in the water
sector, and identifying innovative solutions to address some
of the existing challenges. The independent commission or
taskforce then could draft a water innovation vision and plan
for the state. While a major component of the innovation plan
would be recommendations on how to overcome regulatory
fragmentation and establish a regulatory framework that
promotes and enables innovation, the plan also could address
other obstacles to technological innovation, including pricing
policies and financial challenges. The legislature or governor
then could decide if implementation of the vision requires
a new guiding body such as an innovation office that could
work across agencies and geographic scales, or if an existing
office within the principal water agency or a related agency
can implement the plan.
The state innovation office could have multiple functions. The
office could be primarily tasked to promote recommendations
of the commission or task force and a regulatory environment
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
29
that is supportive of technological innovation, or it could
be tasked to overcome institutional, sectoral, and financial
fragmentation and promote systematic within-sector and
cross-sector coordination on technological advances.
More generally, the innovation office, working closely with
regulatory bodies at various governmental levels, could be
responsible for:
• Examining the continuing role of innovation in promoting
sustainable water management;
•Coordinating and streamlining laws and regulatory
frameworks in order to promote and not hinder
technological innovation;
• Identifying and promoting best management practices,
including appropriate pricing policies, for promoting
innovation;
• Collecting and publishing relevant water resources data,
which are essential to effective evaluation of new water
technologies;
• Acting as a clearinghouse for all funding sources and
identifying and enabling access to nongovernmental
funding sources;
• Encouraging and facilitating cooperative funding and
development of new technologies among multiple water
entities, by, in-part, expanding public–private partnerships;
and
• Promoting coordination on new technologies among and
within sectors (e.g., between water and wastewater agencies,
and between water and energy sectors), as well as across all
relevant jurisdictional levels (local to state to federal).
The innovation office also could be given the authority to
promote the development, testing, and adoption of new
technologies. It could work with water suppliers, for example,
to develop consortia to jointly fund and conduct the testing of
new technologies at scale. Such consortiums could help achieve
economies of scale that are often missing in areas where water
suppliers are highly fragmented; the consortiums also could
help overcome geographic mismatches in benefits and costs.
One model for these consortia is the Electric Power Research
Institute (EPRI). In the aftermath of the large blackout of
1965 (and other noticeable failures of the power sector), the
industry knew that it faced tougher regulation by the federal
government if it did not act to address collective challenges.
The response, in the early 1970s, was the creation of EPRI—
now the world’s premier collective R&D institution for the
power sector.5 Although EPRI is an industry-led research
consortium, it is tightly linked in practice to the regulatory
system since regulatory approval for R&D costs and regulatory
incentives for adoption are critical. The innovation office also
30 The Path to Water Innovation
could have responsibility to disseminate information about
the performance and costs of new technologies to other water
suppliers, in order to encourage appropriate diffusion of
effective technologies.
Regional socioeconomic realities and climatological and
hydrological variability have created a wide range of issues
that require different sets of solutions. Since the challenges that
the water sector faces vary dramatically across the country,
innovation offices can be customized to handle the specific set
of challenges arising in their respective states. Consequently,
the scope and focus of the innovation office would differ to
address various fronts, such as water-quality degradation,
water scarcity, aging infrastructure, flooding, and so forth.
Additionally, it would be ineffective, at least initially, for all
states to adopt their own innovation offices. The largest states
with the greatest water challenges—California, Texas, Florida,
or a consortium of like-challenged states such as those in the
West—are well-positioned to take the lead. Other states could
follow, formulating their offices based on the lessons learned
from the first innovation offices.
Furthermore, the federal government can play a supportive
role to the innovation offices, especially for states that lack
the expertise or funding to promote innovation on their
own. Through the EPA, the federal government could supply
expertise and enable information sharing of best practices
among the states. It could reward best practices with race-tothe-top funds and a periodic innovation report card. It could
also engage public utility regulators such as the nonprofit
National Association of Regulatory Utility Commissioners
(NARUC) to promote adoption of innovation-driving
regulations. NARUC could also play a separate but central role
in evaluating the performance of these innovation offices and
could disseminate the lessons to other states—just as NARUC
does in key areas of electricity and gas regulation.
INSTITUTE A MECHANISM FOR RAISING PUBLIC
FUNDS FOR INNOVATION
In order to create a stable and sustainable source of funding to
finance implementation of innovative projects, we recommend
that authorities institute a surcharge on water usage, or public
benefit charge (PBC). The surcharge would create a pool of
monies that could be used to invest in R&D, reduce the cost of
new technologies, and attract private capital. State legislators,
regulators, and local entities would need to work out the setup and governance of a PBC for each state. The PBC could
be collected and run by local water utilities, or it could be
administered and distributed directly by a statewide entity
such as the water innovation offices discussed in the last
section. Either way, the state should provide clear guidance on
how the money should be invested and leveraged to attract the
maximum amount of capital.
FIGURE 14.
Governance Structure of Public Good Charge for Electricity in California
Electricity
Public Purpose Program (PPP)
Surcharge
Publicly Owned
Utilities (POU)
Investor Owned
Utilities (IOU)
Low-Income
Components
Electricity
Procurement Charge
(2004 onwards)
Public Benefits
Charge (PBC)
POU Administered
Programs
Energy Efficiency
Renewables
Non-Low-Income
Components
IOU Administered
Programs
California Alternative
Rates for Energy
(CARE)
IOU Administered
Programs
Low-Income
Energy Efficiency
(LIEE)
Research and
Development
Energy
Efficiency (EE)
Public Goods
Charge (PGC)
California Energy
Commission (CEC)
Administered Programs
Renewable Energy
Program (REP)
Research,
Development, and
Demonstation
(RD&D)
[PIER Program]
Low Income
Programs
Financing and funding mechanisms play a central role in
the development and adaptation of innovative solutions by
the water sector (EPA 2014). Across the United States urban
water systems are gradually reaching the end of their life
span. In the coming decades communities will need access
to sustainable and reliable sources of financing to replace
degraded infrastructure, expand existing water systems, and
mitigate the impacts of climate change (Forer and Staub 2013).
The water sector should explore new and innovative financing
mechanisms and investment strategies, in parallel to pricing
and regulation reform, to meet necessary urban water needs.
Improved finance is needed both for investment in the core
water system and for innovation itself. The former requires
aligning the incentives for investors. The latter requires
addressing, head on, the reality that many of the benefits of
fundamental innovation are a public good. Better pricing will
to a large degree address these challenges.
The federal government can play a supportive role in financing
and funding the development of innovative solutions. In
particular, the federal government often plays the role of
catalyst through funding R&D and providing low-interest
loans and grants to pilot and implement innovative projects.
The recent establishment of the Water Infrastructure
Finance and Innovation Authority (WIFIA), as part of the
Water Resources Reform and Development Act of 2014, is a
demonstration of the federal government’s potential role.
WIFIA, a five-year pilot program, offers a financing mechanism
to leverage public funds to attract additional private and
public (nonfederal) monies and facilitate development and
implementation of critical water infrastructure. Such efforts
by the federal government in conjunction with other local
public and private financing mechanisms including the PBC
could facilitate a faster rate of innovation in the water sector.
Figure 14 depicts the governance structure of California’s
electricity Public Good Charge program, which was active
for fourteen years (1998–2011) and provides one model for a
PBC in the water sector. California’s legislature established the
Public Good Charge program to support investments in energy
efficiency, renewable energy (including new renewable facilities,
emerging renewables, existing renewables, consumer education,
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
31
and customer credit), and public interest R&D. The California
Solar Initiative illustrates how California’s Public Good Charge
promoted innovation. The Initiative’s aim was to reduce the
cost of new solar technologies while not excessively subsidizing
firms and individuals that adopted the technologies. The
subsidies were funded through the monies collected as part of
the Public Good Charge program in California. Implemented
in stages (the final stage occurred in June 2014), subsidies
started at a high level and then declined—broadly in line with
the improvement in solar technology. Because the schedule for
subsidies was announced far in advance, the California Solar
Initiative created an incentive for early adopters and helped to
accelerate the widespread use of rooftop solar power in the state
(California Public Utilities Commission 2014). This approach of
setting declining subsidies with performance is widely used—
for example with the feed-in tariff in Germany and the sugar
ethanol program in Brazil (see Victor 2011, chap. 6).
32 The Path to Water Innovation
Another example of how a PBC can promote innovation is
the water stewardship rate of the Metropolitan Water District
of Southern California (MWD). In 2002 the MWD added
a fixed charge on its water rates to fund its Conservation
Credits Program, a program that provides financial support
for conservation programs within MWD member agencies
(MWD 2001); funds rebate programs; and supports R&D,
education, and outreach efforts. The funds have also been used
to encourage the deployment of water supply enhancement
projects in the region.
A PBC addresses the water sector’s fundamental challenge of
raising sufficient revenue for innovation given its public-sector
nature. For the 80 percent of the water market that is supplied
through SOEs, a public surcharge on water users is perhaps the
most economically efficient mechanism for raising new capital
while most closely tying the cost to the users of water. Ultimately,
the goal of the PBC is to reverse the long-standing trend of
exceptionally low public investment in water innovation.
Chapter 6: Conclusion
T
The U.S. water sector, while the largest in the world,
has been slow to promote, adopt, and implement new
technological innovations. The water sector has largely
taken a reactive and conservative approach to innovation.
Multiple factors have driven the low level of innovation,
including unrealistically low water rates, regulatory limitations,
lack of access to capital, concerns about public health and
possible risks associated with innovation, the conservative
culture of the industry, and the long life expectancy, size, and
complexity of most water systems. Although the last three
factors are largely endemic to the water sector, new policies
addressing the pricing, financing, and regulation of water can
make the sector more receptive to innovation.
Comparatively robust innovation rates in the clean energy
sector highlight the slow innovation rate in the water
industry. Venture capital and corporate capital investments
are significantly lower in the water sector than they are in the
clean energy sector both in the United States and globally.
Low flows of cash into the water industry have also affected
the number of patent filings in this sector compared to the
clean energy sector.
Our analysis shows that most of the barriers to innovation
are related to the way we govern water. The goal should be to
create an open and flexible environment that is innovation
friendly. In this paper we put forward three recommendations
that we believe are key to moving the water sector forward.
We believe that pricing policies, regulatory frameworks, and
financing and funding mechanisms are the top issues that have
to be addressed in the water sector. Therefore we have offered
specific recommendations explaining how each of these policy
and governance factors can be revised and reformed in order
to facilitate greater innovation. Furthermore, we recommend
that each state draft a water innovation vision that would
identify the state’s challenges and opportunity areas. The
vision can be implemented through the establishment of an
innovation office. More specifically, the office would work
with local governments, water authorities, and other relevant
sectors to promote a series of best management practices
related to pricing policies, to streamline regulations across
and within sectors, and to enable access to funding.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
33
Chapter 7: Questions and Concerns
How can states and local agencies be encouraged or
incentivized to implement the proposed reforms?
Climate change, growing populations, and aging
infrastructure all pose serious challenges to water suppliers.
Water managers will find it difficult to meet these challenges
without new technologies that permit them to do more with
less water and at a lower cost. States and local water agencies
therefore are likely to be supportive of measures that will
ensure more-innovation-friendly regulation and access to
affordable capital; they may be less receptive to price reforms
due to concerns of consumer backlash. Jurisdictions are most
likely to adopt these reforms when they are in the midst of a
serious drought or otherwise face a significant water shortage.
Although state and local governments may naturally support
many of the reforms that we suggest, the federal government also
can play an important role in encouraging and incentivizing
the reforms. First, both the Environmental Protection Agency
(EPA) and the Department of the Interior can help educate
state and local governments on the opportunities for reform
and provide case studies of successful reform efforts. Second,
federal agencies can use existing programs and policies, such
as Interior’s WaterSMART program and EPA’s Clean Water
and Drinking Water Infrastructure Sustainability Policy, to
provide technical and financial assistance to states and local
governments who wish to adopt innovation-friendly pricing
systems, ensure that their regulations are supportive of
innovation, adopt new financing mechanisms, or create water
innovation offices.
Would states need to build additional capacity or provide
additional funding for these reforms?
Most of the reforms presented in this paper, including reforms
to pricing, regulations, and public financing, do not require
significant new capacity or funding from state governments.
The only reform that could require additional capacity or
funding is the establishment of an innovation office. A task
force or commission in each state would initially evaluate the
steps needed to promote innovation, including the potential
value of an innovation office. As part of this evaluation, the task
force would examine the capacity needs of such an office and
how the office might be financed. The exact needs of an office
would depend on its mandate and activities. In some cases,
34 The Path to Water Innovation
a state might be able to create the office without a significant
investment of new resources by reallocating resources within
an existing state agency.
If the innovation office would need new resources, the state
may be able to fund the office and related activities either
by allocating a portion of the funds collected from the
public benefit charge or through funding from the local
water agencies who would benefit from the office. States
could require local agencies to fund the office, or they could
institute a membership model under which local agencies
could voluntarily decide whether to provide funding. In the
energy sector, the Electric Power Research Institute (EPRI)
successfully relies on voluntary subscriptions to support its
activities. Like the Institute, a state innovation office could
open its membership not only to local water agencies, but also
to businesses and other governmental agencies interested in
promoting innovative water technologies. EPRI estimates
that, by pooling the resources of its members, it provides them
with ten dollars in research and development for every one
dollar received in contributions. Under this model, members
would presumably receive benefits, such as the ability to
formulate research goals and access research results, that are
not available to nonmembers. However, other activities, such
as regulatory reform, would benefit all water agencies.
Should there be a mandate for these pricing reforms?
In many cases, state or federal mandates may not be
necessary. Water suppliers will often want to develop larger
and more‑reliable revenue streams in order to respond to
the multiple water challenges facing them. Moreover, some
reforms, such as decoupling revenue from the quantity of
water sales, may not increase water consumers’ rates and
therefore not engender significant political opposition. Other
reforms, such as full-cost pricing and tiered pricing schemes,
may threaten consumers’ budgets and therefore attract
political opposition. Many water suppliers, nonetheless, have
successfully raised rates or reformed their pricing structures.
Education of customers has often been the key to success in
these cases. Consumers are much more likely to accept higher
rates if they understand the necessity of the rate increase or
the benefits of reform.
Both the state and federal governments, moreover, can help
encourage pricing reforms without resorting to mandates. First,
these governments can provide information and programs
designed to help water suppliers explain the necessity of the
reforms to their customers. Second, where state governments
require water suppliers to adopt efficiency or conservation
policies, the states can make pricing reforms such as those
recommended above meet the requirements. The pricing
reforms not only would help promote innovation, but would
also encourage conservation and more-efficient water use.
Where pricing reforms prove impossible, water suppliers or
states might be able to adopt other policies that mimic the
effect of the reforms but with less political opposition. For
example, if a water supplier is unable to raise its rates because
of consumer opposition, the supplier might use a shadow
price (i.e., a price equal to the full cost of the supplier’s water,
including environmental and other costs) to determine
what investments to make in new technology. Innovation
opportunities that may be cost-ineffective when based on
actual water rates could actually be cost-effective when
shadow prices are used instead.
What will be the potential obstacles or resistance to these
reforms?
There are three major obstacles or sources of resistance.
•Salience. The first obstacle is likely to be the low salience
of water issues in normal water years. Most politicians
pay little attention to water issues, except in times of
drought or other crises. Water utilities are often risk-averse
organizations, and water managers attract attention and
lose their jobs only when they err or anger customers. As a
result, the focus is on inaction rather than action. Because
of this obstacle, advocates of more-innovative and moreeffective water systems must be ready to push for reforms
during periods of drought and other crises. Advocates
must also document the serious problems that are likely to
go unsolved in the future if innovation is not promoted.
• Financial Impacts. Water consumers are often likely
to oppose reform measures that will result in higher
water prices. States and other governments also are
likely to oppose reform measures that will require scarce
governmental funding and resources. Despite such
opposition, however, pricing reforms have taken place in
many states and local jurisdictions. Many of our suggested
reforms can be undertaken with little, if any, additional
resources from state or local budgets.
•Complexity. Even as awareness of the importance of
innovation increases, meaningful reforms can often seem
daunting because they implicate so many different actors
and involve so many diverse organizational changes,
including changes in culture. Therefore, not all the proposed
reforms will be adopted and implemented overnight. The
federal government can help by developing case studies
of successful reform efforts and providing states with the
guidance needed to address the complexity of the reforms.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
35
Authors
Newsha K. Ajami
Barton H. Thompson Jr.
Director of Urban Water Policy, Water in the West/ NSF-ERC
ReNUWIt, Stanford Woods Institute for the Environment
Robert E. Paradise Professor of Natural Resources Law
and Perry L. McCarty Director, Stanford Woods Institute
for the Environment
Newsha K. Ajami is the director of Urban Water Policy with
Stanford University’s Water in the West and NSF-ReNUWIt
initiatives. She is a hydrologist specializing in sustainable
water resource management, water policy, the waterenergy-food nexus, and advancing uncertainty assessment
techniques impacting hydrological predictions. Her research
throughout the years has been interdisciplinary and impact
driven, focusing on the improvement of the science-policystakeholder interface by incorporating social and economic
measures and relevant and effective communication.
Barton H. (“Buzz”) Thompson is the Robert E. Paradise
Professor in Natural Resources Law at Stanford Law School,
the Perry L. McCarty director and senior fellow in the Stanford
Woods Institute for the Environment, and a senior fellow in
Stanford’s Freeman-Spogli Institute for International Studies.
Thompson helped found the Woods Institute and has served
as its director since its launch in 2004.
Ajami is a gubernatorial appointee to the Bay Area Regional
Water Quality Control Board. Before joining Stanford, she
worked as a senior research associate at the Pacific Institute
from 2011 to 2013, and served as a Science and Technology
fellow at the California State Senate’s Natural Resources
and Water Committee where she worked on various water
and energy related legislation. She was also a postdoctorate
researcher with the Berkeley Water Center, University of
California, Berkeley. She has published many highly cited
peer-reviewed papers in prominent journals, coauthored two
books, and contributed opinion pieces to the New York Times
and the Sacramento Bee. She was the recipient of the 2005
National Science Foundation award for AMS Science and
Policy Colloquium and ICSC-World Laboratory Hydrologic
Science and Water Resources Fellowship from 2000 to
2003. Ajami received her Ph.D. in civil and environmental
engineering from the University of California, Irvine; an
M.S. in hydrology and water resources from the University of
Arizona; and a B.S. in civil and environmental engineering
from Tehran Polytechnic.
36 The Path to Water Innovation
Thompson is an expert in water law and has written dozens
of articles and books on the subject. His recent books include
Legal Control of Water Resources, now in its fifth edition,
as well as Managing California’s Water: From Conflict to
Reconciliation, with Ellen Hanak, Jay Lund, and others. Much
of his scholarship has focused on the role of private markets
in the water sector. He currently serves as Special Master for
the U.S. Supreme Court in Montana v. Wyoming, an original
jurisdiction dispute involving the waters of the Yellowstone
River system.
Thompson chairs the boards of the Resources Legacy Fund and
the American Farmland Trust. He also serves as a California
trustee for The Nature Conservancy and as a board member
for the Sonoran Institute. He is a former member of the Science
Advisory Board of the U.S. Environmental Protection Agency.
He received his A.B., M.B.A., and J.D. degrees from Stanford
University. Prior to joining the Stanford faculty, he clerked for
then-Justice William Rehnquist of the U.S. Supreme Court
and was a partner with the law firm of O’Melveny and Myers.
David G. Victor
Professor and Director of the Laboratory on International
Law and Regulation, University of California, San Diego
David G. Victor is professor of international relations and director
of the Laboratory on International Law and Regulation and is a
member of the Shultz-Stephenson Task Force on Energy Policy at
the Hoover Institution. His research focuses on highly regulated
industries, such as electric power, and how regulation affects
the operation of major energy markets. He is author of Global
Warming Gridlock, which explains why the world has not made
much diplomatic progress on the problem of climate change, and
explores new strategies that would be more effective.
Prior to joining the faculty at the University of California San
Diego, Victor served as director of the Program on Energy and
Sustainable Development at Stanford University where he was
also a professor at Stanford Law School and taught energy and
environmental law. At Stanford he built a research program
that focused on the energy markets of the major emerging
countries—mainly Brazil, China, India, Mexico, and South
Africa. Earlier in his career he also directed the science and
technology program at the Council on Foreign Relations
in New York and led the International Institute for Applied
Systems Analysis in Austria, one of the first major assessments
of the effectiveness of international environmental law.
He has published 200 articles and books in venues that include
Nature, Science, International Organization, the New York
Times, Financial Times, Foreign Affairs, and the International
Journal of Hydrogen Energy. He is a member of the advisory
council for Nature Climate Change and a member of the
editorial board of Climatic Change; he joined the board of the
Electric Power Research Institute in 2013.
Acknowledgments
The authors would like to thank The Hamilton Project for this opportunity. We also would like to thank those who have offered
data, information, and comments on the paper. We also thank Dr. Stuart Muller, Linda Wong, and Noemi Wyss for research
assistance and the S. D. Bechtel Jr. Foundation, the Electric Power Research Institute, BP plc, the Norwegian Research Foundation,
and the University of California, San Diego for their generous support.
The Hamilton Project • Brookings | Stanford Woods Institute for the Environment
37
Endnotes
1. Evapotranspiration is the loss of water to the atmosphere both by evaporation from the soil surface and by transpiration from the plants growing on it.
2. Two large SOEs in the energy sector—the Tennessee Valley Authority and
Bonneville Power Authority—are major exceptions.
3. Comparisons between the sectors are hard to make with precision because
technologies do not fit in neat boxes. For the purpose of this paper, the term
“clean energy” encompasses renewable and non-fossil-fuel-derived energy,
and energy efficiency. Unless otherwise indicated, clean energy includes
biomass generation, energy efficiency, energy storage, geothermal, hydro
and marine power, nuclear, smart grid, solar, and wind.
4. In California alone, literally thousands of different entities—local governments, special districts, and privately owned water companies—manage
and deliver water at the local level. Domestic users receive water from about
400 large retailers and several thousand smaller, typically rural, retailers.
Hundreds of separate agricultural water districts provide water to the state’s
farming community (Hanak et al. 2011).
5. While most EPRI spending is focused in the United States, in some areas—
such as nuclear power—the institution essentially spans the whole globe
since the key lessons learned from R&D are global and the relevant funders
of such work are increasingly outside the United States.
38 The Path to Water Innovation
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(in Memoriam)
SUSAN ORR
Palo Alto, California
WILLIAM J. PATTERSON (1966-2010)
(in Memoriam)
GEORGE PHIPPS
Woodside, California
JAY A. PRECOURT
Edwards, Colorado
WILLIAM PRICE III
Larkspur, California
ALISON WRIGLEY RUSACK
Santa Barbara, California
STEVEN EDWARDS SANDERSON
Savannah, Georgia
VICKI SANT
(Member Emerita)
Washington, DC
AKIKO YAMAZAKI
Los Altos Hills, California
engage stakeholders and leaders from around the world to create
practical solutions for people and our planet. Learn more: woods.
stanford.edu
EXECUTIVE LEADERSHIP TEAM
JEFFREY R. KOSEFF
Perry L. McCarty Director and Senior Fellow of the Stanford
Woods Institute for the Environment; William Alden Campbell
and Martha Campbell Professor of Civil and Environmental
Engineering
BARTON H. “BUZZ” THOMPSON, JR.
Perry L. McCarty Director and Senior Fellow of the Stanford
Woods Institute for the Environment; Robert E. Paradise
Professor in Natural Resources Law
The Hamilton Project • Brookings
3
Highlights
Newsha K. Ajami and Barton H. Thompson Jr. of the Stanford Woods Institute for the Environment, and
David G. Victor of the University of California, San Diego, propose a set of forward-looking policies to
promote innovation in the water sector. They call for fundamental reforms in utilities’ pricing of water,
systematic reviews of regulatory practices, and a new mechanism for utilities to raise revenue to finance
new infrastructure investment.
The Proposal
Adjust the price of water charged by utilities so that it captures the full cost of delivery;
implement tiered pricing so that consumers face the full marginal cost of consumption; and
decouple revenue from the quantity of water sold. These changes would promote conservation
measures by giving users better incentives to curtail water use, while also enhancing the financial
stability of water utilities.
Conduct a systematic statewide review of regulatory practices and create water innovation
offices to better coordinate the research and development of new technologies across the
industry. The statewide review of regulatory practices would seek to minimize variation of rules across
jurisdictions and related sectors, and provide flexibility to avoid blocking the timely adoption of new
technologies. Statewide innovation offices can be shaped to drive any of the reforms and to support
other endeavors such as information-sharing with water utilities and distributing funds for research and
development.
Institute a surcharge on water usage, called a public benefit charge, to create a stable and
sustainable source of funding for infrastructure investment. The surcharge would create a pool
of monies that could be used to invest in research and development, to pay for adoption of new
technologies, and to attract private capital.
Benefits
These reforms confront the most pressing challenges to innovation in the water sector. The authors
emphasize that improving the financial sustainability of utilities through better pricing strategies and
enhanced access to capital would help to unlock funding opportunities for innovative new technologies.
In addition, the authors contend that regulatory reform would break down the legal protections for
status quo technologies. Evidence from both the water sector, where these reforms have thus far
been implemented only on a small scale, and the clean energy sector demonstrate the benefits of the
proposal.
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Informing
Students
about Their College Options: A Proposal for Broadening the Expanding College Opportunities Project
WO O D S . S TA N F O R D. E D U